G10 FX Weekly – Yen strength an opportunity

by: Georgette Boele , Roy Teo

G10-FX-Weekly-9-July.pdf (145 KB)
  • Yen outperforms and could strengthen to 118 versus the US dollar in the coming days…
  • … this would be an opportunity to position for weakness afterwards
  • The euro is likely to weaken further



Yen could strengthen to 118 in the coming days…

The Japanese yen was the outperformer, strengthening to 120.50 against the US dollar due to safe haven flows and relatively cautious FOMC minutes. Further declines in China’s equity markets and unfavourable outcome in this Sunday’s EU summit would support the yen further. If USD/JPY were to drop below 120, this could trigger rumoured stop losses below 120, and could accelerate the sell-off in USD/JPY. As a result, USD/JPY could approach 118.00. Then we would expect the pair to stabilise.


…this would be an opportunity to position for weakness afterwards

However, we expect USD/JPY to move higher in the coming months for the following reasons. For a start, we expect the US Federal Reserve to start hiking interest rates in September and to hike in 2015 and 2016 more than financial markets currently anticipate. In addition, USD/JPY is very sensitive to developments in interest rate spreads. Expectations about an upcoming Fed rate hike should result in a widening of the interest rate spread between the US and Japan. Therefore, it is highly likely that USD/JPY will rally. Moreover, it is unlikely that a Greek exit will result in a Lehman-like reaction in financial markets. So any yen safe haven buying by investors will probably be temporary. This would be an opportunity to buy USD/JPY. Moreover, we do not expect a major slowdown in the Chinese economy. The Chinese authorities have an enormous arsenal to support the economy. Taking all the above into account, we expect USD/JPY to rise to 128 at the end of this because of monetary policy divergence, widening bond yield spread between the US and Japan and an improvement in investor sentiment.

Euro is likely to weaken further

The Greek No-vote resulted in euro weakness and EUR/USD reached a low of 1.0916. However, the euro recovered afterwards, because of some hopes that Greece may come to a deal with its creditors and euro crosses (EUR/CHF, EUR/GBP, EUR/JPY) were well supported. An unfavourable outcome this weekend, would weigh on euro and previous low in EUR/USD of 1.0458 (close) will likely be reached in the days afterwards.

Commodity currencies feel the pressure

Weakness in commodity prices (metals and oil) negatively affected commodity currencies such as the Australian dollar, Canadian dollar and the Norwegian krone. The Australian dollar slumped to the lowest level since the middle of 2009 as Australia’s key commodity export iron ore price declined by more than 20% in the past week due to renewed worries on China’s demand. They will likely remain vulnerable if the Fed hikes rates later in the year and the US dollar rallies.